United States: Supreme Court Rules SEC Has Five Years to Seek Penalties

In an important decision, the Supreme Court held that the SEC
has five years from when a fraud occurred to file an action to seek
civil penalties. Although the ruling was limited to civil
penalties, the decision might prompt lower courts to apply a
five-year limitations period to other types of relief sought by the
SEC. The decision will also put more pressure on the SEC to
move faster in its investigations.

In a unanimous decision, the Supreme Court of the United States
ruled in Gabelli v. SEC that the U.S. Securities and
Exchange Commission (SEC) has five years from when a fraud
occurred, and not from the SEC's discovery of the fraud, to
seek civil penalties in enforcement actions.
Gabelli v. SEC, 568 U.S. ___
(2013).

In 2008 the SEC brought an action against defendants for aiding
and abetting the antifraud provisions of the Investment Advisers
Act of 1940, based on allegations of allowing market timing in a
mutual fund. Gabelli, 568 U.S. at *2–*3. The
complaint sought an injunction, disgorgement and a civil
penalty. Because the complaint was filed more than five years
after the last alleged violation, the district court dismissed the
penalty claim under 28 U.S.C. Section 2462's five-year statute
of limitations. On appeal, the U.S. Court of Appeals for the
Second Circuit reversed, holding that the discovery rule should be
read into Section 2462 for claims based on fraud. The Second
Circuit ruled that, under Section 2462, a fraud claim did not
"accrue" until the SEC discovered it or could have
discovered it based on "reasonable diligence."

In the Gabelli decision, the Supreme Court declined to
read the discovery rule into Section 2462 based on the plain
language of the statute and strong policy reasons.
Gabelli, 568 U.S. at *9–*11. The Supreme Court
explained that the most natural reading of the statute was that a
claim accrues when the plaintiff has a cause of action. The
Court stressed that this reading furthers the purpose of the
statute of limitations to reduce stale claims and create more
certainty for defendants about their potential liabilities.
The Court also found that historically the discovery rule had not
been used to assist the government to recover penalties in
enforcement actions. Instead, the rule has been used to
assist "defrauded victims" to recover compensation
"where a defendant's deceptive conduct may prevent a
plaintiff from even knowing that he or she has been
defrauded." Because private plaintiffs are not "in
a state of constant investigation ... and do not typically spend
[their] days looking for evidence that they were lied to or
defrauded," the Court explained that they are afforded the
benefits of the discovery rule. By contrast, the Court found
that the SEC does not need these protections, as its mission is to
investigate potential securities violations and it has an arsenal
of tools for doing so (including, as discussed in the opinion,
issuing subpoenas, making awards to whistleblowers and offering
cooperation agreements).

The Court also relied on important policy considerations to
support its decision. The Court explained that applying the
discovery rule to Section 2462 would "leave defendants exposed
to Government enforcement action not only for five years after
their misdeeds, but for an additional uncertain period into the
future." Gabelli, 568 U.S. at *9.
Additionally, the Court noted the practical difficulties that would
exist if courts had to determine when the government "knew or
should have known" of a fraud. For example,
complications would arise when the government would assert
privileges, as courts (and defendants) tried to ascertain the
reasonable diligence of the government.

While the Court held that the SEC has five years to seek civil
penalties, the decision did not address two related and important
issues. The Court did not address whether the equitable
tolling doctrine—"when the defendant takes steps beyond
the chal¬lenged conduct itself to conceal that conduct from the
plaintiff"—can be applied to Section 2462, and
effectively provide the SEC with additional time beyond the five
years. The opinion explained that because the SEC previously
abandoned this issue, it was not before the Court. However,
some of the Court's reasoning in rejecting the application of
the fraud discovery rule would appear to support an argument that
equitable tolling is inapplicable to Section 2462. For
example, the Court's textual analysis of Section 2462, as well
as its policy considerations, would support such an
argument.

The second issue not discussed in the opinion was whether
specific SEC remedies (such as injunctions, suspensions or bars)
are considered "penalties" within the meaning of Section
2462, as some courts have held. For example, in Johnson
v. SEC, the U.S. Court of Appeals for the District of Columbia
Circuit held that Section 2462 precluded the SEC from suspending a
brokerage firm supervisor, when the SEC filed its action after the
five-year period. 87 F.3d 484 (D.C. Cir. 1996). More
recently, the U.S. Court of Appeals for the Fifth Circuit relied on
the Johnson case in holding that injunctions and officer
and director bars constituted "penalties" subject to
Section 2462's five-year limitations period. SEC v.
Bartek, No. 11-10594 (5th Cir., Aug. 7, 2012). These
issues are expected to be the subject of further litigation.
As a result, the SEC may face additional challenges in pursuing not
only monetary penalties, but these other types of relief, based on
stale
conduct.

As a practical matter, the decision will put more pressure on
the SEC to move faster in its investigations, something that it has
tried to do for years. The decision will hopefully force the
SEC to become more efficient in its approach to investigations by,
among other things, adopting a more targeted approach.

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